Costco Stock: Bargain Price… or Dead Money?

by Gerelyn Terzo | July 7, 2014 1:45 pm

Source: Flickr[1]

Costco stocks wholesale quantities of goods at low prices

Costco Wholesale (COST[2]) shareholders haven’t had much to cheer about in 2014, with the Costco stock price actually declining 2% amid an S&P 500 that’s up 7% during the same period and wishful rumblings of Dow 20k in the air.

On the surface, the losses seem unwarranted, especially in light of the fact that Costco has been outperforming its biggest brick-and-mortar rival Sam’s Club, owned by Walmart (WMT[3]), on a comparable-store sales basis.

But Costco also has been facing heightened competition from the likes of Amazon.com (AMZN[4]), whose Amazon Prime goes head to head with COST’s membership model and whose Amazon Fresh takes aim at Costco’s grocery business.

Which leaves us with the question — is now the time to scoop up Costco stock before Wall Street appreciates it a little more, or do we leave it alone as the company faces greater headwinds?

Costco – A Formidable Company

Indeed, Costco’s comps performance has been impressive. While Costco’s comps have dropped off 2011 levels, they still advanced a robust 6% in fiscal 2013. Plus, that 6% likely is affected by Costco’s 26 store openings (nine more than fiscal 2012), as those stores not only aren’t included in comps figures, but often can steal sales from existing locations.

Costco plans maintain a similar pace of new-store openings for fiscal 2014 and fiscal 2015, which could have a similar cannibalizing effect, at least for the short term.

Even then, Costco’s results still look better than Sam’s Club. While Sam’s Club generated “positive comparable club sales” in fiscal 2014, according to Walmart’s annual report, that momentum is waning. In the most recently reported quarter, Sam’s Club’s comp sales took a hit, falling 0.5% excluding low-margin fuel sales, and falling 0.8% including fuel.

Meanwhile, in its most recent quarter, Costco reported that comps grew 4%, led by its U.S. locations.

Amazon – A Formidable Competitor

Where one starts to begin about Costco’s stock price[5] is when you start to consider Amazon, whose grocery delivery service Amazon Fresh threatens to steal share away from COST. In fact, in a recent interview with CNBC, Costco co-founder Jim Sinegal said Amazon Prime might be a copycat of Costco’s own warehouse membership model, for which he seems to harbor no resentment.

Cowen and Company’s Faye Landes lays it out in a recent research report:

“As AMZN continues to grow rapidly in the U.S., more and more COST members shop on AMZN and are Prime members. Thus far the two retailers are co-existing nicely, but we think that COST’s exposure to AMZN, and, especially, AMZN Prime, bears watching.”

Despite the looming threat of Amazon Fresh — which with a mere 1% market share position could derail other grocers’ EBIDTA by as much as 10%, according to Deutsche Bank analysts on CNBC — Costco has no intentions of replicating Amazon’s food-delivery business. Instead, Costco is relying on its lower prices to prevail, according to execs on the company’s most recent earnings call.

Nonetheless, Landes, who has a “market perform” rating on COST, goes on to say that “The visitation for COST members on AMZN is…86% this year, up from 81% a year ago.”

Unfortunately for Costco, those members aren’t just visiting Amazon — they’re pitching a tent. According to Landes, the penetration of Amazon Prime among Costco members sits at 35%, up 7% from the prior-year period.

Bottom Line On Costco’s Stock Price

Despite COST’s underperformance, Costco stock still is rather pricey at current levels. Costco shares trade[6] at 25 times next year’s earnings — a reflection of shareholder optimism, sure, especially compared to WMT’s 15 and AMZN’s stratospheric 280 … but still expensive.

Of course, unlike Amazon, Costco is profitable.

Shareholders also are priority No. 1 at Costco. The company repurchased more than $180 million worth of shares in its fiscal Q3 and recently lifted its quarterly dividend 15% to 35.5 cents per share.

Costco no doubt is facing some headwinds originating from its home state of Washington, where Amazon is also headquartered. But as the architect of the membership model, the warehouse store has proven it can lead.

I’d bet on Costco stock before the market identifies the opportunity.

As of this writing, Gerelyn Terzo did not hold a position in any of the aforementioned securities.